Chapter Three-Activity Cost Behavior20104611037

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					                Hansen, Mowen, Elias & Senkow (ITP, 1998)




Chapter 3 - Activity Cost
      Behaviour




          Chapter 3-1
                           Hansen, Mowen, Elias & Senkow (ITP, 1998)



          Learning Objectives

   Define and describe cost behaviour and
    explain the role of the resource usage model
    in understanding cost behaviour.
   Separate mixed costs into their fixed and
    variable components using the high-low
    method, the scatterplot method, and the
    method of least squares.
   Evaluate the reliability of a cost equation.
   Explain the role of multiple regression in
    assessing cost behaviour.
   Describe the use of managerial judgement in
    determining cost behaviour.
                     Chapter 3-2
                            Hansen, Mowen, Elias & Senkow (ITP, 1998)



              Basic Terms - 1

   Activity capacity: the ability to perform
    activities
   Practical capacity: the efficient level of
    activity performance
   Resources: economic inputs that are
    consumed in performing activities
   Resource spending: the cost of acquiring
    capacity to perform an activity
   Resource usage: the amount of activity
    capacity used in producing the activity output


                      Chapter 3-3
                             Hansen, Mowen, Elias & Senkow (ITP, 1998)


              Basic Terms - 2

   Resources supplied as used and needed:
    these are resources that are acquired from
    outside sources, where the terms of
    acquisition do not require any long-term
    commitment for any given amount of the
    resource. Examples: materials & energy
   Resources supplied in advance of usage:
    these are resources acquired by the use of
    either an explicit or implicit contract to obtain
    a given quantity of resource, regardless of
    whether the quantity of the resource available
    is fully used or not.

                       Chapter 3-4
                                       Hansen, Mowen, Elias & Senkow (ITP, 1998)



                     Cost Behaviour
    Fixed Costs Behaviour                    Variable Cost Behaviour

$                                  $
    Relevant Range




    Activity                                    Activity

    Unit Cost Varies with Volume            Unit Cost Rate is Constant


                             Chapter 3-5
                          Hansen, Mowen, Elias & Senkow (ITP, 1998)



   Total versus Average Variable Cost

Example:
 Suppose that Porter Pottery Company makes
 mugs. Each mug requires 1/4kg. of clay at $2
 per kg. If Porter manufactures 5,000 mugs,
 the total cost of clay is $2,500 (5,000 x $2 x
 .25). If Porter manufactures 10,000 mugs, total
 cost of clay is $5,000 (10,000 x $2 x .25). The
 average cost of clay per mug stays at $0.50
 (.25 x 2) no matter how many mugs are made.




                    Chapter 3-6
                            Hansen, Mowen, Elias & Senkow (ITP, 1998)



   Total versus Average Variable Cost

Total Variable Cost

Cost                                           TVC = $.5X

$5,000

$2,500

            5,000             10,000
                      Mugs
                      Chapter 3-7
                         Hansen, Mowen, Elias & Senkow (ITP, 1998)


   Total versus Average Variable Cost
               (continued)

Average Variable Cost
Cost



$0.50                                      AVC = $0.50




           5,000           10,000
                   Mugs
                   Chapter 3-8
                         Hansen, Mowen, Elias & Senkow (ITP, 1998)



 Total Fixed versus Average Fixed Cost

Total Fixed Cost
Cost
$1,500                                        Year 2

$1,000                                        Year 1

$500

               Activity Level

                   Chapter 3-9
                         Hansen, Mowen, Elias & Senkow (ITP, 1998)


 Total Fixed versus Average Fixed Cost
               (continued)

Total versus Average Fixed Cost

Cost



                                                 TFC
                                                AFC

               Activity Level

                   Chapter 3-10
                                 Hansen, Mowen, Elias & Senkow (ITP, 1998)



   The Behaviour of Mixed Costs
Linearity Assumption

                                               Total Costs

$Cost
                                                Fixed Costs
                          Variable Costs




         Number of Units Produced
Total Costs = Fixed Amount + Variable Cost Per Unit x Number of Units
            = Fixed Costs + Variable Costs
          Y = F + V(X)
           Y= Total mixed costs (the dependent variable)
         (X) = Cost Driver or Independent Variable
                           Chapter 3-11
                                Hansen, Mowen, Elias & Senkow (ITP, 1998)



             Step Variable Costs
Linearity Assumption


                                               Narrow Width
$Cost




         Number of Units Produced




                          Chapter 3-12
                Hansen, Mowen, Elias & Senkow (ITP, 1998)



Types of Fixed Costs

  Committed Fixed Costs
 Discretionary Fixed Costs
     Step Fixed Costs




          Chapter 3-13
                                 Hansen, Mowen, Elias & Senkow (ITP, 1998)



              Step Fixed Costs
Linearity Assumption



$Cost


                                                  Normal Operating
                                                  Range (Relevant Range)



                       Number of Units Produced




                           Chapter 3-14
                    Hansen, Mowen, Elias & Senkow (ITP, 1998)


Methods for Separating Mixed
Cost Into Fixed and Variable
        Components
      The High-Low Method
       Scatterplot Method
   The Method of Least Squares




              Chapter 3-15
                      Hansen, Mowen, Elias & Senkow (ITP, 1998)



 Mixed Costs: An Example
Month      Utility Costs              Unit Produced
January     $2,000                       200
February      2,500                     400
March         4,500                      600
April         5,000                      800
May          7,500                     1,000




                Chapter 3-16
                            Hansen, Mowen, Elias & Senkow (ITP, 1998)



    The High-Low Method
Variable Cost Rate = (Y2 - Y1)/(X2 - X1)
                  = ($7,500-$2,000)/(1,000-200)
                  = $5,500/800
                  = $6.875 per unit

Fixed Costs       = Y2 - VX2
                  = $7,500 - ($6.875 x 1,000)
                  = $625

The cost formula using the high-low method is:

    Y = $625 + $6.875 (X)



                     Chapter 3-17
                                    Hansen, Mowen, Elias & Senkow (ITP, 1998)
  Utility
  Cost               Scatterplot Method
$8,000

            Important: Cost function is only
                                                         .
            relevant within relevant range
 6,000
                                              .
 4,000
                                    .        Analyst can fit line
                          .                  based on his or her
                                             experience
 2,000          .
     0        200       400      600    800              1,000
                         Units Produced


                              Chapter 3-18
                             Hansen, Mowen, Elias & Senkow (ITP, 1998)


The Method of Least Squares
           X       Y         XY         X   2       Y   2


           200 $2,000       400,000           40,000 $4,000,000
           400    2,500   1,000,000          160,000    6,250,000
           600    4,500   2,700,000          360,000 20,250,000
           800    5,000   4,000,000          640,000 25,000,000
          1,000 7,500     7,500,000        1,000,000 56,250,000
          3,000 $21,500 $15,600,000        2,200,000 $117,750,000


V = [ XY -  X Y/n]/[ X2 - ( X)2/n]
 = 2,700,000/400,000
 = $6.75
                                             The cost formula is:
F =  Y/n-V X/n
 = $21,500/5 - [$6.75(3,000/5)]
                                             Y = $250 + $6.75 (X)
 = $250
                       Chapter 3-19
                              Hansen, Mowen, Elias & Senkow (ITP, 1998)


The Method of Least Squares:
      Goodness of Fit
 R2 (Coefficient of Determination) = V[ XY- X Y/n]/[ Y2- ( Y)2/n]

 R2 = .944




 R (Coefficient of Correlation) = Square root of R2
                                = .972




                        Chapter 3-20
                 Hansen, Mowen, Elias & Senkow (ITP, 1998)



   Product Complexity and
       Multiple Drivers

    TC = FC +V1C1 + V2C2


Recommended Use of Multiple
Regression


           Chapter 3-21
                        Hansen, Mowen, Elias & Senkow (ITP, 1998)


Cost Behaviour and Managerial
         Judgement

       Some Tips
          Use past experience
          Try to confirm results with operating personnel
          Use common sense to confirm statistical studies




                  Chapter 3-22
                   Hansen, Mowen, Elias & Senkow (ITP, 1998)


Numerical Questions from back
    of chapters 2 and 3

        W2-3, E2-9, P2-1, P2-9
          W3-3, E3-9, P3-1




             Chapter 3-23
                        Hansen, Mowen, Elias & Senkow (ITP, 1998)



           Question W2-3

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                  Chapter 3-24
                        Hansen, Mowen, Elias & Senkow (ITP, 1998)



           Question E2-9

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                  Chapter 3-25
                        Hansen, Mowen, Elias & Senkow (ITP, 1998)



           Question P2-1

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                  Chapter 3-26
                        Hansen, Mowen, Elias & Senkow (ITP, 1998)



           Question P2-9

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                  Chapter 3-27
                        Hansen, Mowen, Elias & Senkow (ITP, 1998)



           Question W3-3

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                  Chapter 3-28
                        Hansen, Mowen, Elias & Senkow (ITP, 1998)



           Question E3-9

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                  Chapter 3-29
                        Hansen, Mowen, Elias & Senkow (ITP, 1998)



           Question P3-1

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                  Chapter 3-30
       Hansen, Mowen, Elias & Senkow (ITP, 1998)



The End




 Chapter 3-31

				
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